Canada: What Is The Effect Of Piercing The Corporate Veil?

When the court pierces the corporate veil of a corporation, can another party be found to be the real party to the contract? Or is that other party only subject to consequential relief and not contractual relief? That is the issue which the English Court of Appeal recently faced in VTB Capital Plc v. Nutritek International Corp. That Court recently held that even in the face of fraud and other serious wrongdoing, the other party cannot be held to be a party to the contract unless the corporation which was shown as a party to the contract was a façade or sham.

The identity of the parties to a contract is fundamental to the contract's legal existence and its commercial viability. In the context of building contracts, that identity is even more important since the parties undertake inter-related performance obligations and are relying upon the creditworthiness of the other parties to make sure that the project is completed. So the decision in VTB Capital should be carefully analyzed by those concerned with building contracts.

The Factual Background

The claim arose from a loan by VTB Capital, a company incorporated in England which carried on business as a bank in London. VTB Capital was controlled by a Russian state bank. The loan was to a company (RAP) incorporated in Russia, and was for the purpose of RAP buying six dairy companies in Russia. Other related agreements were also made, including a share warrant deed and participation agreement. The loan was not repaid and VTB Capital commenced an action in the English courts and sought to serve the claim on the defendants outside England. VTB Capital originally alleged that it was induced to enter into the loan by two other Russian companies and a Russian individual (the "Russian third parties"). It then sought to amend its claim to "pierce the corporate veil" of RAP, and assert that RAP was really only a puppet of the Russian third parties and that they were the real parties to the contract. VTB then asked permission to serve its claim outside England, with that contractual allegation included in the claim.

The English Court of Appeal held that when a corporation is a party to a contract and the corporate veil of the corporation is sought to be pierced so as to make others liable, then apart from the case where the corporation is a façade or sham, those others are not liable as parties to the contract. The other parties are only liable for consequential relief or based upon separate tortious or other wrongdoing. Accordingly, the Court of Appeal held that the new contract claim against the three Russian companies was not a valid legal claim and refused to permit the claim with this contractual allegation to be served outside England.

Piercing The Corporate Veil

The Court of Appeal undertook a lengthy review of English case law concerning "piercing the corporate veil." It agreed that the corporate veil of a corporation can be pierced if there are "special circumstances....indicating that [the corporation] is a mere façade concealing the true facts." Yet, it held that a proper reading of English cases disclosed that the "fraudulent or dishonest use of a company by its corporators or controllers so as to conceal the latters' true identities" cannot in law possibly make those third party corporators or controllers the real and original parties to the contract. Rather, the corporation remained the party to the contract. If the corporators and controllers were to be held liable, that could occur through consequential remedies which would hold them accountable for monies or benefits received or for other equitable remedies, or they might be liable based upon separate tortious claims.

The Court of Appeal refused to apply the agency doctrine of undisclosed principals to this situation. The court said that the law on that subject was "anomalous". On the facts of the case, the court said that the doctrine could not apply because "the puppeteers [had not] authorized the puppets to enter into the contracts on their behalf", and because "VTB [did not intend] to contract with anyone other than the counterparties" named in the contracts.

The Court of Appeal accordingly found that the judicial authorities

"do not, however, go to the length of treating the puppet company as other than a legal person that is formally distinct and separate from the puppeteer; and were they to do otherwise, they would be ignoring the principles of Salomon. Consistently with that, they do not provide any basis for the proposition that the puppeteer should be regarded as having always been a party to a contract to which it or he plainly was not a party."

This decision will have to be read very carefully. A bald conclusion - that the fraudulent or dishonest use of a company whereby the real actors' identity is not disclosed cannot give rise to contractual liability for those actors -appears to raise serious legal questions, at least in Canada.

Moreover, this decision was given in the context of an application to serve the claim outside the jurisdiction and not upon the ultimate merits of the case. So the ambit or application of the decision may be somewhat in doubt. The following are some of the apparent limitations of the decision.

First, the Court of Appeal did not doubt that, if the corporation was a "façade or sham", then the corporate veil could be pierced. So, the VTB Capital decision involves a party to a contract which was a real party with a real corporate existence. What amounts to a "façade" or "sham" in any particular case may be a factual issue, but the present decision does not exclude the contractual liability of a third party if the corporate party fits within those words. However, if the "puppet" is a real and existing entity, then the puppet and not the puppeteer is liable.

Second, the Court of Appeal did not hold that, if the facts of a case fit the doctrine of undisclosed liability, then that doctrine cannot and should not be applied. All it held was that the present facts could not be "shoe-horned" (as it said) into that doctrine.

In essence, the Court of Appeal accepted the "façade or sham" basis for piercing the corporate veil but rejected the two other submissions for doing so.

First, it rejected the proposition that the court has a general power to pierce the corporate veil and that the court could hold the third party contractually liable "in the interests of justice."

Second, it rejected the proposition that the corporate veil could be pierced if "the company was involved in some impropriety". If the latter conduct existed, then the "relevant wrongdoing must be in the nature of an independent wrong that involves the fraudulent or dishonest misuse of the corporate personality of the company for the purpose of concealing the true facts", and not the contractual liability of the wrongdoer.

There is little doubt that, the next time a plaintiff in the Anglo-Canadian context attempts to pierce the corporate veil, the decision in VTB Capital will be pulled off the shelf, or downloaded from bailii. It is a densely written decision which cited many English decisions. But it cited no cases from Canada where the "corporate veil" issue has been frequently addressed.

On policy grounds, the decision adheres strictly to traditional contract law limiting the effect and enforcement of a contract to the parties named in it. The English Court of Appeal made a policy decision not to allow fraudulent corporate activity to give rise to a contract remedy against third parties. It did so at a time when courts, at least in Canada, are giving broader effect to contracts and allowing them to be enforced by third parties, and when Canadian courts seem inclined to provide wide remedies against corporate fraud. The future impact of the VTB Capital will depend, at least in Canada, on whether the same policy choice is made in Canada as was made in England.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.) at Chapter 1, Part 1(a)(i)(E)

VTB Capital Plc v. Nutritek International Corp., [2012] EWCA 808

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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